Friday, June 29, 2012

Banker bonuses win again: EU leaders agree to use rescue mechanism to bailout banks

As reported by Bloomberg and the Wall Street Journal, EU leaders have tentatively agreed to use funds from the European Financial Stability Fund and the European Stability Mechanism to purchase bank equity.

The clear immediate winners are the bankers.  Rather than having to write-down the loans and securities they made and bought to reflect the inability of the borrowers to repay, they will be able to pay themselves bonuses instead.

The clear immediate losers from the ongoing implementation of the Japanese model for handling a bank solvency led financial crisis are taxpayers.  Their money is going to be used to purchase equity in banks.  This has been tried repeatedly without success since the beginning of the financial crisis.

Buying equity in Spanish and Italian banks will not convince anyone that the banks or the sovereigns are solvent.

Rather, what buying equity in these banks allows is the purchase by these banks of more sovereign debt and the pledge of this debt to the ECB.  This is an important because it transfers more of the losses in the banking system onto the taxpayers who ultimately will have to pay for losses at the ECB, EFSF and ESM.

The way the transfer works is as follows:  Spanish and Italian banks use the combination of 'new' equity and ECB funds to purchase Spanish and Italian bonds from the non-Spanish and Italian banks at artificially high prices (remember:  Spanish and Italian banks are the only buyers of this junk in the market as everyone knows these countries have already issued too much debt).

This transfers losses that should have been realized by say German banks, think Deutsche Bank, to the Spanish and Italian banking system.  A transfer that clearly justifies the payment of bonuses by the selling banks as they have avoided realizing a loss.

Please note, while German banks escape the losses and its banker bonuses are protected, the same is not true for the German taxpayer.  The German taxpayer is still on the hook for the losses at the ECB that provided the money to the Spanish and Italian banks to buy their sovereign debt at inflated prices.

As your humble blogger keeps pointing out, bankers are great at offering recommendations for solving problems.  Unfortunately, any recommendation that comes from a banker is by definition good for the banker.  The question that must be answered is whether the recommendation is good for anyone else.

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